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Defining P50 and P80 Manual

UNCLASSIFIED
Department of Finance
Defining P50 and P80

Defining P50 / P80

P50 and P80 refer to a confidence level regarding the probability of the cost not being
exceeded, and does not indicate a quantum of cost or proximity to the actual cost realised.
That is, P80 is not a cost plus/minus 20% but instead it is a cost that will not be exceeded
80% of the time.

Risk profiles take the shape of the asymptotic ‘S’ curve shown below. The curve shown is for
a fictional representative project with an arbitrary parametric cost estimate of \$1,000 and a
simplified risk profile. This demonstrates the position of the P50 and P80 confidence level
estimates and risk allowances (contingencies). Note that to reach P100, all risks would be
identified and allowed for at their estimated cost, leading to an impractically large
contingency allowance (observe the asymptotic nature of the probability curve) or require an
excessive time to deliver the project. Conversely, if the parametric estimate (in this example
\$1000 with P15 confidence) was all that was allowed for, that is with no contingency
allowance, then the cost will be exceeded in almost every circumstance. Clearly, prudent
project management and informed investment decision requires a consistent confidence
level applied to all projects. It is for this reason that the entities must use a P50 confidence
level in the cost estimate at First Stage of the Two Stage Capital Works Approval Process
and requires a P80 confidence at Second Stage Approval.

0.9

0.8
P80 Confidence Level

0.7

0.6

0.5
P50 confidence level

0.4

0.3

0.2

0.1

0
\$700.00
\$800.00 \$900.00 \$1,000.00 \$1,100.00 \$1,200.00 \$1,300.00
\$1,400.00
Base Estimate Normal S Distribution
Project Cost P50 Confidence Level P80 Confidence Level
Cost for P50 P80 cost

UNCLASSIFIED
UNCLASSIFIED
Department of Finance
Defining P50 and P80

Note that base estimate is a parametric cost with ‘most likely’ values for inherent risks (range
risks). This value is not P0 as a consequence of range risks which have the potential to result
in a lower cost (though unlikely). Where this line intersects the S curve indicates the cost
confidence associated with that estimate on the represented risk profile (in this case the
parametric estimate is approximately P15 – the other way to consider this confidence level is
that the parametric estimate will be exceeded by some amount 85% of the time).

The S Curve is a cumulative probability curve arising from the normal distribution analysis of
the risks identified.

Note that the graph above demonstrates the difference in risk allowance between a P50 and
a P80 cost estimate. However, this is only at a moment in time – the refinement, realisation
and retirement of risks through the due diligence investigations between First and Second
Stage approvals will change both the base case and the standard deviation on the
normalised distribution of risk, changing the placement of P50/P80 points on the cumulative
probability curve.

In practice the progression from P50 at First Stage Approval P80 at Second Stage Approval
involves the refinement, retirement and realisation of many identified risks. This usually
results in the base case estimate increasing and the contingency allowance decreasing
commensurately. However, if the estimate was in fact P50, this should be the case in only
half of all projects, while the other half have budget estimates that decrease through maturity.
The reality shows this not to be the case indicating probable optimism bias in the estimates
or inadequate recognition/assessment of risks.

It is also critical to ‘lock-in’ the scope of the project at Second Stage Approval, as any further
changes to the project scope and performance will also have flow on effects to the project
cost and risk. Should the scope or performance change, the assumptions and estimates
would affect the overall cost and risk profile for the project and would certainly alter the
project from what was agreed by Government at Second Stage Approval.

UNCLASSIFIED
UNCLASSIFIED
Department of Finance
Defining P50 and P80

Ascertaining your P50 or P80 confidence level cost

Deriving the appropriate cost confidence requires a cumulative assessment of the applicable
risks. There are two different risk categories that form the risk profile: inherent (range) risk
and contingent risk.

Range risk involves assessing the highest likely, lowest likely and most likely cost impact of
an event that will occur (probability =100%). This may be a range of both quantity and rate
separately, or combined.
3 3
Example - the bulk earthworks are assessed as 200,000m at \$25 per m with the quantity and
rate combined range being -20%, 100%, +40%. The range of costs for this is:
 Lowest likely = (200,000 x \$25) -20% which equals \$5.0m x 0.8 = \$4.0m.
 Highest likely = (200,000 x \$25) +40% which equals \$5.0m x 1.4 = \$7.0m.
 Most Likely = (200,000 x \$25) -0% = \$5.0m.
The mean value is then considered the base estimate plus risk and so the risk allowance to
include is the mean minus the most likely.
Contingent risk is an assessment of, and allowance for, unmeasured items. These may
include items such as weather, geotechnical problems, political issues, design/owner
requirements and other similar unknowns. These risks have a probability of less than 100%
chance of occurring. As such, the risk needs to be allowed for in the contingency in a
probabilistic manner. That is: cost (\$) x likelihood of occurrence (probability %).
To ascertain the appropriate risk allowance, the risks and costs are viewed as a normalised
cumulative cost probability as shown in the graph above.
Ascertaining the normalised cumulative cost probability curve is done by use of the Monte
Carlo simulation method where all identified risks are simulated over a number of projects
probabilistically to ascertain the normal distribution of risk costs. This can be completed using
a random number generator in a spreadsheet application to determine the mean and
standard deviations of costs derived from the simulation. This represents the application of
the accumulated risks (both inherent and contingent).

For additional information on application of the P50 and/or P80 confidence level/s to costing